United States District Court, S.D. New York
GARY ZAGAMI, individually and on behalf of all others similarly situated, Plaintiff,
CELLCEUTIX CORPORATION, LEO EHRLICH, and KRISHNA MENON, Defendants.
OPINION AND ORDER
KATHERINE POLK FAILLA United States District Judge.
Opinion and Order dated June 8, 2016, this Court granted the
motion of Defendants Cellceutix Corporation
(“Cellceutix”), Leo Ehrlich, and Krishna Menon
(together, “Defendants”) to dismiss the Second
Amended Complaint filed by Plaintiff Gary Zagami. See
Zagami v. Cellceutix Corp., No. 15 Civ. 7194 (KPF), 2016
WL 3199531 (S.D.N.Y. June 8, 2016), appeal withdrawn
(Sept. 6, 2016). Shortly thereafter, Defendants moved
pursuant to the mandatory review provision of the Private
Securities Litigation Reform Act of 1995 (the
“PSLRA”), 15 U.S.C. § 78u-4(c)(1), for a
finding that the lawsuit amounted to “abusive
litigation, ” and for the consequent imposition of
sanctions pursuant to Rule 11 of the Federal Rules of Civil
Procedure. For the reasons set forth in the remainder of this
Opinion, Defendants' motion is denied.
to resolution of the instant motion is an understanding of
the events underlying the filing of the three complaints in
this matter. That history is presented, with appropriate
detail, in this section. Familiarity with the Court's
prior decision on Defendants' motion to dismiss, and with
the scientific and financial terminology discussed therein,
The Parties to the Action
is a clinical-stage biotechnology company developing several
drugs for approval by the Food and Drug Administration (the
“FDA”), including the drugs Kevetrin and
Brilacidin. (SAC ¶¶ 2, 13). Defendant Krishna Menon
has served as President, Chief Scientific Officer, Director,
and Chairman of the Board of Cellceutix since 2007.
(Id. at ¶ 14). Defendant Leo Ehrlich has served
as Chief Financial Officer and Director of Cellceutix since
2007, and as the company's Chief Executive Officer since
2010. (Id. at ¶ 15).
Gary Zagami purchased Cellceutix securities during the class
period alleged in the SAC. (SAC ¶ 12).
The Mako Research Report
August 6, 2015, a short seller of Cellceutix securities using
the pseudonym “Mako Research” posted an article
(the “Mako Research Report”) on the website
Seeking Alpha; the author contended that Cellceutix
was a “sham” company and purported to identify
(and explain the falsity of) misrepresentations and omissions
of material fact in the company's public statements.
(See Sullivan MTD Decl., Ex. 1 (Mako Research
Report); see also SAC ¶ 5 (alleging that
Defendants' fraud “began to be exposed” with
publication of the Mako Research Report)).
Mako Research Report was the crux of Plaintiff's claims
of fraud, and is now the crux of Defendants' motion for
sanctions; it thus merits a detailed analysis. The Report is
38 pages long when printed out, with certain pages taken up
by graphs, charts, and photographs. The thesis of the article
was stated up front; it is lengthy, but worth repeating:
Cellceutix is run out of what appears to be an empty office
building, and no one answers the phone - it appears that this
is nothing more than a shell corporation.
CTIX science is demonstrably unviable, rendering this public
shell likely worth substantially less than its current value.
The company is run by a management team with a long history
of self-enrichment and shareholder value destruction.
One of these insiders has repeatedly issued false statements
about his background.
CTIX is a black hole of related party transactions, enriching
consulting agreements, and financing arrangements with known
Ponzi scheme fraudsters as financing partners.
The company's fair value is 96-99% lower than the current
price. CTIX should be avoided. This stock is dangerous.
I have been a professional investor for nearly a decade and
have researched over 1, 000 stocks, and I believe that
Cellceutix is far and away the worst public company I have
ever seen. The company is rife with unethical conflicts of
interest from insiders who appear to be recycling a
historically effective playbook that has resulted in
self-enrichment at the expense of minority shareholders. This
team of insiders has been involved in numerous stock market
wipeouts that have cost shareholders untold fortunes.
The “company” is run out of a shell office that
was leased to CTIX by the company's president. Numerous
calls to management went unanswered.
There is a strong probability that (OTCPK:CTIX) is
manipulated by stock promoters and overseas boiler rooms,
which is explained below.
Additionally, after hiring an independent scientist with a
Doctorate in Biochemistry to review Cellceutix's
“science, ” I have concluded that the
company's drug pipeline is without merit and is likely
entirely without value, as detailed below.
I value shares of Cellceutix at $0.09 in a best-case
scenario, which is 96% lower than the current price, and
recommend that investors avoid this company entirely.
It's clear to me that Cellceutix is very likely to end up
as a complete wipeout for shareholders over time, and stands
to continue declining significantly if we experience more
near-term market volatility. I am appalled that this company
is even allowed to remain public, and recommend that the SEC
immediately begin an investigation into all related parties
and trading activity in CTIX stock.
(Sullivan MTD Decl., Ex. 1 at 1).
succeeding 37 pages, the author added flesh to the bones of
his thesis. On the issue of Cellceutix's office space
(which presumably went to the bona fides of the
company's endeavors), the author included pictures of the
office “taken in early August 2015 during business
hours.” (Sullivan MTD Decl., Ex. 1 at 2-3). The
pictures show no one, and were presented to supplement the
author's contention that repeated efforts to contact
Cellceutix personnel by telephone were unsuccessful.
author then spent six pages debunking the science behind the
three pharmaceutical products that are the lifeblood of
Cellceutix, prefacing his comments as follows:
As my research below demonstrates, the entire pipeline of
drugs that the company boasts about continuously in its press
releases is likely to be entirely without value. My
conclusion is based on due diligence conducted by an
independent Doctor of Biochemistry, who spent weeks
researching CTIX's claims. This person is a published
medical researcher who has extensive clinical trial research
(Sullivan MTD Decl., Ex. 1 at 4). Addressing first the
antibiotic Brilacidin, the author contended that the drug (i)
was ineffective and caused adverse side effects in patients;
(ii) had been purchased from a bankrupt company named
PolyMedix (suggestive to the author of a prior market
determination that the product had no value); (iii) would be
“difficult to commercialize”; (iv) did not work
as to most types of bacterial infections (particularly
Gram-negative infections); and (v) was ineffective in reducing the
risk of infection for those experiencing oral mucositis.
(Id. at 4-7). Proceeding next to the
cancer-treatment drug Kevetrin, the author maintained that
the drug did not target cancer stem cells, and was touted
because of its effects on a biomarker gene, p21, that the
author characterized as “invalid.” (Id.
at 7-8). Finally, and more summarily, the author
criticized Cellceutix's anti-psoriatic drug Prurisol,
which the author claimed was less effective than other drugs
and had worse side effects. (Id. at 9).
here, the author proceeded to attack Cellceutix's senior
management, beginning with Menon, who was alleged to have
misstated or overstated his resume (including by reporting a
degree from Harvard University that he did not receive), and
to have had ties to other biochemical companies that
“all … appear to be shell companies designed to
enrich insiders.” (Sullivan MTD Decl., Ex. 1 at 10;
see also Id. at 9-12). Along with his co-defendant
in this case, Menon was identified as part of the
“Ehrlich-Menon Value Destruction Team, ” with
charts purporting to demonstrate the loss in value of
securities at two other companies with which the two were
involved, StatSure Diagnostics and NanoViricides.
(Id. at 12-15). The two officers were also alleged
to have been “tied up with Ponzi scheme
financiers.” (Id. at 16; see generally
Id. at 16-32).
post ended as it began: The author importuned investors to
“completely avoid CTIX stock, as I estimate it has
96-99% downside from the current price.” (Sullivan MTD
Decl., Ex. 1 at 35).
The Filing of the Equity Alert
hours after the Mako Research Report was posted,
Plaintiff's counsel issued an “Equity Alert”
news release, which stated in relevant part:
The Rosen Law Firm, a global investor rights law firm,
announces it is investigating potential securities claims on
behalf of shareholders of Cellceutix Corporation (OTC: CTIX)
resulting from allegations that Cellceutix may have issued
materially misleading business information to the investing
On August 6, 2015, Seeking Alpha published an
article revealing that Cellceutix misrepresented the efficacy
of its drug candidates Brilacidin, Kevetrin, and Prurisol. On
this news, shares of Cellceutix fell sharply during intraday
trading on August 6, 2015, damaging investors.
The Rosen Law Firm is preparing a class action lawsuit to
recover losses suffered by Cellceutix investors. If you
purchased shares of Cellceutix before August 6, 2015, please
visit the firm's website at
http://rosenlegal.com/cases689.html for more
(Sullivan MTD Decl., Ex. 18; compare Id. at 1
(reflecting issuance of Equity Alert at 12:41 p.m. Eastern
Daylight Time), with id., Ex. 1 at 1 (reflecting
posting of Mako Research Report at 10:30 a.m. Eastern Time)).
The original plaintiff in this action, Nicole O'Connell,
authorized the filing of a securities class action complaint
that same day; she certified that she had read the Rosen Law
Firm's proposed complaint and authorized its filing, but
no complaint was in fact filed that day. (Compl., Ex. 1).
next day, Cellceutix responded with a press release (the
“August 7 Press Release”) that provided
information regarding, among other things, four clinical
trials in which it was involved. (See Sullivan MTD
Decl., Ex. 2; SAC ¶¶ 26, 28, 45-47; see
also SAC ¶ 5 (alleging that press release confirmed
the falsity of certain of Defendants' prior public
August 7 Press Release comprised nine pages of small-font
type, and endeavored to address each science-based criticism
contained in the Mako Research Report by summarizing the
criticism and then setting forth facts designed to refute it.
First, as an easy retort, Cellceutix presented competing
office photographs that depicted some of its employees.
(Sullivan MTD Decl., Ex. 2 at 1-2). It then addressed more
substantive matters, such as the Report's criticisms of
Brilacidin, noting in part that:
The hyper-linked table provided by the shorter is misleading
and irrelevant as it focuses exclusively on key Gram-negative
bacteria. Brilacidin is for treating [G]ram[-]positive
infections such as acute bacterial skin and skin structure
infections (ABSSSI) caused by Staphylococcus aureus,
including methicillin-resistant strains (MRSA), and was not
developed for the treatment of Gram[-]negative infections.
(Id. at 2; see also Id. at 2-6 (setting
forth additional point-by-point refutations of the scientific
criticisms proffered by the author of the Mako Research
Report concerning Brilacidin; noting, in particular, that
arguments based on the drug's status as a peptide failed
because Brilacidin was in fact a nonpeptidic mimic of an
antimicrobial peptide)). And with respect to the Mako
Research Report's claims regarding Kevetrin, Cellceutix
rejoined that (i) the drug was still in a Phase 1 clinical
trial; (ii) it had shown significant activity in combating
cancer cells; (iii) it did not, and did not claim to, have
any effect on cancer stem cells; and (iv) the clinical trial
maligned by the poster was developed in consultation with
experts at the Dana-Farber Cancer Institute. (Id. at
reports were published in response to the Mako Research
Report. First, on August 11, 2015, Dr. Richard W. Scott of
the Fox Chase Chemical Diversity Center wrote to Seeking
Alpha seeking a retraction of the Mako Research Report.
(Def. Sanctions Reply, Ex. 3). Scott detailed his prior
involvement with the development team at PolyMedix (the
entity from which Cellceutix had purchased Brilacidin), as
well as the reasons why he considered the Mako Research
Report's reference to an “unviable science”
to be “patently untrue.” (Id. at
Scott also dismantled arguments in the Mako Research Report
that were, to him, so “specious and in certain
instances laughable” that they caused him to doubt the
author's references to consultation with an
“independent scientist with a Doctorate in
Don Seiffert, the Life Sciences Editor of the Boston
Business Journal, sought to investigate the Mako
Research Report's “empty office” claims. On
August 14, 2015, he published an article entitled, “My
Visit to Cellceutix, the biotech that a short seller recently
called a sham.” (Def. Sanctions Reply, Ex. 2). In
preparation for the article, Seiffert met with Ehrlich and
Menon to discuss Cellceutix's technology, and took a tour
of the 12, 000-square-foot facility, including its labs.
(Id. at 2).
The Complaint and the First Amended Complaint
over one month after the publication of the Mako Research
Report, on September 11, 2015, the Rosen Law Firm filed a
class action complaint on behalf of Nicole O'Connell
against Defendants. The Complaint recited violations of
Sections 10(b) and 20(a) of the Securities Exchange Act of
1934 (the “Exchange Act”), 15 U.S.C. ...